I run a small private investment partnership, which invests globally with a macro theme. I would say the study of economics is best done in the tradition of the gentleman economists of the past, such as David Ricardo, Adam Smith and John Stuart Mill. Previously, I was an economist and macro strategist for a firm that served institutional investors. My book Gold: the Once and Future Money was released in 2007, and is now available in German, Chinese, Korean and Russian. My opinion pieces have appeared in the Financial Times, Asian Wall Street Journal, Dow Jones Newswires, Worth, Daily Yomiuri, Asia Times, Pravda, Huffington Post, and numerous other print and online publications. I also have a personal website at newworldeconomics.com.

Does A Commodity Basket Standard Measure Up To Gold

I taunted you last week to try to come up with a better system than a gold standard system, for attaining our goal of stable value. Not so easy, is it?

One idea that has been bouncing around for many years is the “commodity basket” idea. I don’t think today’s commodity basket advocates consider it original, but I wonder if they know just how long it has been around.

The economist William Stanley Jevons wrote a book about it in 1875, called Money and the Mechanism of Exchange. In the book, Jevons himself writes about the history of the idea:

Among valuable books, which have been forgotten, is to be mentioned that by Joseph Lowe on “The Present State of England in regard to Agriculture, Trade, and Finance,” published in 1822. … In Chapter IX. Lowe treats, in a very enlightened manner, of the fluctuations in the value of money, and proceeds to propound a scheme, probably invented by him, for giving a steady value to money contracts. He proposes that persons should be appointed to collect authentic information concerning the prices at which the staple articles of household consumption were sold.

People have held the idea for centuries that gold is a standard of stable value. Probably every culture has used some other commodity at some point, whether it be wheat, copper, cocoa beans and so forth. Warehouse receipts for tobacco were used as money in colonial Virginia. However, all of these systems were later abandoned for ones based on gold. This happened in Europe, in Asia, in Africa, and, to some extent, even in the pre-Columbian Americas.

We should respect this outcome generated from centuries of experience, not some coffeehouse debate.

However, people naturally want to see what evidence there is of gold’s stability. As I have mentioned, this is quite difficult, since if there were some definitive benchmark of value that was superior to gold, against which gold could be measured, we would use that as a standard of value instead of gold.

Most of the commodity basket fans seem to mistake the value and the so-called purchasing power of gold, assuming they are one and the same. Last week we discussed how these ideas are very different. This is obvious if you think about it. The purchasing power of $100 in Manhattan is much less than the same $100 in Ecuador. However, on the same day, the value of $100 is the same in both places. The $100 didn’t change.

If you compare gold to a basket of commodities, going back to about 1500 in Britain, we find that the “price of commodities” in gold is remarkably stable. However, commodities prices go up and down in the short term, related to the “supply and demand for commodities” as Ludwig Von Mises would say. In other words, if the weather is bad, we would expect prices to rise, when measured in a currency of stable value, and when there is a surplus of commodities perhaps due to a bountiful harvest, we would expect prices to fall.

If we just considered gold to be perfectly stable in value – a rather overambitious assumption – we would expect to see something much like the actual historical record, of commodities prices going up and down somewhat. Most of the variation is closely related to wars, for reasons you can imagine.

The commodities basket fans often assume that their commodity basket is a perfectly unchanging measure of value (or “purchasing power” since they commingle the two). Thus, any deviation of price is assumed to be a variation in gold’s value/purchasing power. Once you begin with this flawed assumption, you end up with two conclusions: first, that gold’s value/purchasing power seems quite unstable, and second, that a commodity basket is superior, because we have assumed beforehand that it is a representation of stable “purchasing power.”

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.

Comments

I’ve never quite been able to grasp the finer points of tying a currency to gold. I don’t understand what is done when more currency is needed? As an economy expands, the number of transactions and volumes of goods and services expand, doesn’t a limited amount of currency then have to be spread through the greater volumes? That indicates to me that everything must devalue to fit within the limited amount of currency available for transactions. What happens when people save? Doesn’t that effectively diminish the amount of currency in circulation. These issues could be mitigated some by a large increase in the velocity of money. How do we avoid massive financial collapses (1800s) and bank runs?